Cost Accounting
Definition and Purpose?
Definition: One branch of managerial accounting that provides valuable information. Cost accounting accumulates data on current-period actual costs in order to give management unit-cost information.
- A unit-cost can be defined as the incurred expense that can be attributed to a single measured unit of work.
- Primary purpose: to improve management’s understanding of business activity and performance.
Cost Accounting
Factors Affecting Choice of Cost Accounting System
Some of the factors that should affect a company’s choice of its cost techniques are:
• size of the company and its management philosophy;
• organizational structure;
• manpower and technical skills available;
• available EDP resources;
• mix of business;
• distribution system; and
• management’s desire to implement costing techniques.
Classifying Expenses
Expenses as used here are those cost items generally included in the Annual Statement exhibits, Analysis of Operations by Lines of Business, General Expenses, Taxes, Licenses and Fees (Excluding Federal Income Taxes), and Dividends and Coupons Applied, Reinsurance Commissions and Expense Allowances and Commissions Incurred.
- Expenses incurred by a life insurance company can be classified into three broad categories:
• by class or nature of expense (the so called natural classification),
• by organizational unit, or
• by purpose or benefit.
Classifying Expenses (Classified into three broad categories: 1. by class or nature of expense (the so called natural classification), 2. by organizational unit, or 3.by purpose or benefit)
By Class or Nature?
Examples of the first class of expense include such items as rent, salaries and wages, travel expenses, printing and stationery, and all other costs in common classifications based on the nature of the article or service acquired.
Classifying Expenses (Classified into three broad categories: 1. by class or nature of expense (the so called natural classification), 2. by organizational unit, or 3.by purpose or benefit)
By Organizational Unit?
- Classifying expenses by organizational unit normally includes expense groupings by department, cost center, or a combination of the two.
Department: A department is a unit of the company based on some administrative need for control. * In most cases, the assignment of expenses to departments is related to the company’s organization chart and is done primarily to support a responsibility accounting system. Such a system is one that relates each item of expense back to the individual to be held accountable for the expenditure
Cost center: Cost centers may be used in addition to, in support of, or in some cases in place of, departmental breakdowns of costs. A cost center is a predetermined unit of operation for which costs are accumulated for eventual use in the cost accounting system.The unit differs from a departmental accumulation in that its prime purpose is to facilitate eventual allocation or reporting of expenses. * The allocation is accomplished by bringing expenses together by logical activity.
Classifying Expenses (Classified into three broad categories: 1. by class or nature of expense (the so called natural classification), 2. by organizational unit, or 3.by purpose or benefit)
By Purpose or Benefit?
Two major areas of expense classifications fall under this heading: 1. functional costing; and 2. costing by line of business, product, or strategic business unit.
- Functional costing combines all component costs of a particular series of operations into one total, without regard to traditional departmental lines or account classifications.
• Direct costs are those associated directly and logically with a specified function.
• Indirect costs can be analyzed as internal or external.
Internal-indirect amounts are costs within a department that are attributable to more than one function. External-indirect expenditures are costs of a department that provide benefit or service to other departments. - costing by line of business, product, or strategic business unit. These lines of business are the basic or major insurance products offered by life insurance companies.
Classifying Expenses (Classified into three broad categories: 1. by class or nature of expense (the so called natural classification), 2. by organizational unit, or 3.by purpose or benefit)
Interrelationship between Expense Classifications
- Internal-indirect costs, such as the salaries of a multifunction, multiline accounting department, are usually coded by department/cost center. By such coding, the costs are accumulated for eventual spreading to functions and/or lines of business based on reports detailing an allocation of the work performed.
- External-indirect costs (i.e., those originating in one department as a result of service to others) are usually first accumulated by their own department or cost center. After the complete cost of these service operations has been determined, the costs are apportioned either directly to a function/line of business or to the using department/cost center for subsequent function/line of business allocation.
Classifying Expenses (Classified into three broad categories: 1. by class or nature of expense (the so called natural classification), 2. by organizational unit, or 3.by purpose or benefit)
Reasons for Expense Analysis
- Determining the cost of developing products.
- Determining the cost of using alternative distribution systems.
- Developing costs for comparative purposes.
- Assisting in the evaluation of profitability for individual products and/or strategic business units (SBUs).
- Isolating costs for affiliated company expense allocations.
- Cost control through responsibility accounting and general availability of cost data.
- Providing a source of data for other operations. Statistics developed by a cost system are used in varying degrees by actuaries for product pricing and asset share and model office calculations; by accountants to make the adjustments necessary to convert statutory financial statements to a GAAP basis; by work methods personnel to evaluate procedural changes; and by many others.
Departmental Expenses
Uses of Departmental Costs.
Support a responsibility accounting system?
Two important uses for all inclusive departmental accounting are to 1. support a responsibility accounting system and 2. to facilitate subsequent allocations to function/line of business
- Supporting a Responsibility Accounting System: The
assignment of departmental codes, and thus the cost accounting system itself, enters into the picture when reports comparing budget versus actual expenses are made.In a typical situation, the manager of the general accounting department submits a budget
for the various controllable expense items of that department.
Controllable costs are those that managers can be held responsible for, since their decisions will affect the level of expenditures for these items.
Noncontrollable costs are influenced little or not at all by the department manager because they are controlled by another individual with higher or wider authority. An example is the department’s apportioned amount of the company’s total cafeteria expense.
Departmental Expenses
Uses of Departmental Costs.
Facilitating Subsequent Allocations?
Two important uses for all inclusive departmental accounting are to 1. support a responsibility accounting system and 2. to facilitate subsequent allocations to function/line of business
- Facilitating Subsequent Allocations. The charging of as many expenses as is feasible to departments can simplify procedures and yet increase the accuracy of subsequent function/line of business costing.
Departmental Expenses
Operating vs. Service Departments
An operating center usually can be directly associated with one or more functions. Examples of operating departments are those for underwriting, application processing, premium collection, and claims.
It is not so easy to allocate the costs of a service center, since it facilitates the activities of operating cost centers and thus only indirectly affects their functions.
Functional Expenses
Relationship of Functional Costs and Lines of Business
Functional costing
is the accumulation of the total costs of operations needed to achieve a specific purpose, without regard to the organizational unit that incurs the expense.
Costing by line of business
is the accumulation of the total costs of developing, maintaining, marketing, and administering a particular product or SBU without regard to the organizational unit that incurs the expense.
Functional Expenses
Benchmarking to Improve a Company’s Performance
Organizations that provide benchmarking information?
LOMA
Ward Financial Group
Functional Expenses
Procedures for Functional Lines of Business Analysis
Benchmarking to Improve a Company’s Performance
(1 Defining the System, 2 Identifying the Functional Operations to be Measured, 3 Allocation of Service,
Overhead and other functions to line of Business, 4 Providing Cost Segregations of the Functions, 5 Establishing and Calculating Units of Measure, Reporting Results)
1 Defining the System?
Benchmarking: is the search for those best practices that will lead to the superior performance of a company.
develop a complete comprehension of the current procedures. A detailed review of the various classifications of expenses, allocation procedures, EDP availability, etc., must be made.
Functional Expenses
Procedures for Functional Lines of Business Analysis
Benchmarking to Improve a Company’s Performance
(1 Defining the System, 2 Identifying the Functional Operations to be Measured, 3 Allocation of Service,
Overhead and other functions to line of Business, 4 Providing Cost Segregations of the Functions, 5 Establishing and Calculating Units of Measure, Reporting Results)
- Identifying the Functional Operations to be Measured
Remember that the system being illustrated combines both the functional and the line of business costing into one process. This combination is accomplished primarily by segregating the major lines of business by function.
Functional Expenses
Procedures for Functional Lines of Business Analysis
Benchmarking to Improve a Company’s Performance
(1 Defining the System, 2 Identifying the Functional Operations to be Measured, 3 Allocation of Service, Overhead and other functions to line of Business, 4 Providing Cost Segregations of the Functions, 5 Establishing and Calculating Units of Measure, Reporting Results)
- Allocation of Service, Overhead and other functions to line of Business
Service functions include companywide (centralized) cost of purchasing operations, personnel administration, payroll, and employee training, recruiting, and benefit
plans.
Overhead functions include items that cannot be assigned directly with certainty to any other function. Specific examples include costs for executive officer salaries and related items, board of director fees, long range planning, general legal work, general planning, methods and procedures work, forms control, work measurement, corporate insurance, public relations, corporate advertising, and centralized accounting, budget, and cost control activities.
Other functions may include those not classifiable in service, overhead, or any other line of business function
Functional Expenses
Procedures for Functional Lines of Business Analysis
Benchmarking to Improve a Company’s Performance
(1 Defining the System, 2 Identifying the Functional Operations to be Measured, 3 Allocation of Service, Overhead and other functions to line of Business, 4 Providing Cost Segregations of the Functions, 5 Establishing and Calculating Units of Measure, 6 Reporting Results)
- Providing Cost Segregations of the Functions
When discussing classification of expenses by purpose or benefit, expenses can be characterized by one of three degrees of cost assignment: direct, internal-indirect, and external-indirect.
Direct costs are those that can be associated directly and logically with a specified functional line of business. Such costs can be salary, salary-related, or other expense items. Direct costs are associated directly and logically without regard to whether they are salary, salary-related, or other
Indirect Cost (internal or external) allocated based on the particular expense items included in each allocation base. Can be divided among three allocation bases: salary expenses, salary-related expenses, and other expenses.
Internal-indirect costs are those within a particular department attributable to more than one function.
Functional Expenses
Procedures for Functional Lines of Business Analysis
- Providing Cost Segregations of the Functions. Can be divided among three allocation bases: salary expenses, salary-related expenses, and other expenses.
Allocating Internal-indirect Salary Expenses?
- Methods:
1. Actual Time Studies:Perhaps the most sophisticated, this method involves the measurement of actual time spent on various functions. It offers the advantage of accuracy and the disadvantage of cost, but is generally recommended where feasible.
- Historical Standards Applied to Current Counts. time studies of the past are used to establish standards or normal time requirements for each job activity.
- Questionnaires: recognizes the familiarity most people have for their assigned work, as well as the unfamiliarity most people have for the needs of cost accounting. The purpose of this method is to describe the job of the person being studied in terms that are familiar but adaptable to cost requirements.
- Estimated Time: The last, least sophisticated, but yet widely used method of allocating salary costs is estimated time
Functional Expenses
Procedures for Functional Lines of Business Analysis
- Providing Cost Segregations of the Functions. Can be divided among three allocation bases: salary expenses, salary-related expenses, and other expenses.
Allocating Internal-indirect Salary-related Expenses?
Salary-related expenditures are those nonsalary expenses that are allocated on the same percentage basis as salaries. There are primarily two reasons for using the salary percents on these expenditures.
- is that many of them are by definition very similar to salary costs.
- materiality
Functional Expenses
Procedures for Functional Lines of Business Analysis
- Providing Cost Segregations of the Functions. Can be divided among three allocation bases: salary expenses, salary-related expenses, and other expenses.
Allocating Internal-lndirect Other Expenses?
defined earlier as those not classified as salary or salary-related
Functional Expenses
Procedures for Functional Lines of Business Analysis
- Providing Cost Segregations of the Functions. Can be divided among three allocation bases: salary expenses, salary-related expenses, and other expenses.
Allocating External-lndirect Other Expenses?
External-indirect costs were defined earlier as those incurred by a department providing benefit or service to other departments, which costs may be attributed to one or more functions within the respective departments. External-indirect costs can be divided into three different kinds of benefits or services:
- corporate overhead,
- EDP centers,
- service centers other than EDP.
Functional Expenses
Procedures for Functional Lines of Business Analysis
Benchmarking to Improve a Company’s Performance
(1 Defining the System, 2 Identifying the Functional Operations to be Measured, 3 Allocation of Service, Overhead and other functions to line of Business, 4 Providing Cost Segregations of the Functions, 5 Establishing and Calculating Units of Measure, 6 Reporting Results)
5 Establishing and Calculating Units of Measure
Now that the total expenses have been allocated to functions, the next consideration is methods of analyzing the respective totals.
The actual calculation of the unit value is accomplished by dividing the total costs applicable to the unit selected by the number of selected units.
Functional Expenses
Procedures for Functional Lines of Business Analysis
Benchmarking to Improve a Company’s Performance
(1 Defining the System, 2 Identifying the Functional Operations to be Measured, 3 Allocation of Service, Overhead and other functions to line of Business, 4 Providing Cost Segregations of the Functions, 5 Establishing and Calculating Units of Measure, 6 Reporting Results)
6 Reporting Results
degree of summarization increases as one goes up the management ladder
Departmental Expenses
- A department was defined earlier as a unit of the firm based on some administrative need for control. This administrative need, in many instances, is related more to the organizational chart than to company costing requirements.
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Chapter 251
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Chapter 358
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Chapter 427
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Chapter 521
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Chapter 655
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Chapter 718
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Chapter 823
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Chapter 918
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Chapter 1018
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Chapter 1120
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Chapter 1237
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Chapter 1317
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Chapter 1425
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Chapter 1520
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Chapter 1626
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Chapter 17 - Budget24
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Chapter 18 - Strategic Planning8
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Chapter 19 - Management reports18
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Chapter 20 - Mergers and Acquisitions20
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Chapter 2120
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Chapter 2220
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Chapter 24 - Internal Control22
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Chapter 25 - Reinsurance25
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Chapter 262
